Types of Real Estate Loans—And How to Apply for Them

Real estate is booming right now. In May 2021 alone, home sales were up 44.6 percent from the previous year. Given this rise, many people are looking to get into the real estate game.

Whether you are looking to buy a primary residence or make your first real estate investment, you are likely wondering how to apply for real estate loans. Are you trying to learn what types and options are available?

Read on to learn how to apply for a real estate loan and make your investment dreams a reality.

In this article:

• Commercial vs Residential Loans
• Bank vs Private Loans
• Conventional Loans
• Hard Money Loans
• Home Equity Loans
• Crowdsourced Real Estate Loans

Commercial vs Residential Loans

Depending on whether a property is a commercial or residential property, there are different types of loans available. Commercial loans are often for larger amounts of money than residential loans for the simple reason that commercial properties are often larger than residential properties.

Common types of commercial buildings include office space, retail space, industrial buildings, and apartments, for example.

Typically, investors need to have a lower loan-to-value (LTV) ratio for commercial loans. A loan-to-value ratio is calculated by comparing the amount of your mortgage (how much you are borrowing) to the price of the property. For example, a 70% loan-to-value ratio would mean that you are taking out a loan for 70% of the property value.

A simpler way to say this is that commercial properties often require higher down payments. This is because the higher your down payment, the lower your LTV ratio.

For residential properties, borrowers can typically get a higher loan-to-value ratio, depending on the type of loan and lender. In some cases, you can might be able to acquire a residential property for little to no money down. For example, you could use a USDA loan or a VA loan to buy a home for no money down or a FDA loan to acquire a home for as little as 3.5% down.

Also, commercial loans usually have shorter terms than residential loans. Commercial loans typically range from five to 20 years, while residential loans can be up to 30 years.

Finally, loan rates are often higher for commercial loans, but the rates vary between lenders. You need to think about these differences when you look at the various types of properties you may invest in.

Bank vs Private Loans

Next, you need to think about whether you want a private money loan or a bank loan. Private money loans are from one individual to another and can be from friends, family, or an investor. You can also meet private money lenders by going to real estate investment network events.

The main difference between private money and bank loans is the interest rates and loan terms.

Similar to a bank loan, private money loans will involve a legal contract that will protect your lender and allow them to foreclose on your property if you default on payments. This is why you need to carefully consider your relationship with the person who is lending you money.

Conventional Loans

The most common form of financing is a bank loan or a conventional loan. With this approach, a financial institution will lend you money based on your credit history, income history, and your ability to repay the loan.

Typically, investment property interest rates are higher than those for a primary residence (often about 1 to 1.5% higher), but the rates can still be favorable based on your credit. Typically, the larger your down payment, the better the interest rate you can get.

While conventional loans are some of the most stable loan types to get, there are still risks involved. For example, if you own a rental property where you can’t secure a tenant for several months, you will still have to make your mortgage payments.

Banks can also have a longer approval process than a private money loan and they tend to have stricter criteria around the number of mortgages that you can have open at one time.

To learn more about the differences between bank loans vs. private loans, find more information here.

Hard Money Loans

Another type of loan for real estate investment is a hard money loan. These loans are best for short-term investing like flipping a property instead of renting it out or developing it.

The main benefit of hard money loans is that they are typically easier to qualify for than conventional loans. Lenders will still review your income and credit, but they mostly focus on the property’s potential profit.

They will look at a home’s estimated after-repair-value (or ARV) to determine if you will be able to repay the loan after making needed renovations. You may be able to get a loan in a few days instead of months.

The biggest drawback of these loans is the interest rates. Typical rates can reach as high as 18% depending on the lender. You also have less time to pay the loan back than other loan types. Plus, your closing costs and origination fees will usually be higher, so that will eat away at your returns.

Given these realities, most investors use a hard money loan to buy a property quickly and then repay this loan with a conventional loan or home equity line of credit if they decide to keep the property over time.

Starting out with a hard money loan and switching it to another loan type once the property is rehabbed or rented out (producing income), is a common approach among seasoned real estate investors.

Home Equity Loans

You can also get money by drawing from your home equity by opening a home equity line of credit (HELOC) or a home equity loan. You may be able to borrow up to 80% of your home’s equity value that you can use toward rehabilitation, repair, or the purchase of a new investment property.

By opening a HELOC, you borrow against your home’s equity, although you will have to make monthly payments just like you do with a credit card. The rates can be variable and may increase if the prime rate changes.

You can also do a cash-out refinance with a fixed rate, which is a popular way to tap into your home equity if your home appreciates in value over time. Unfortunately, this approach will extend the life of your existing mortgage and cause you will pay more interest over time.